While many pundits spent December warning about a "bubble" in high-yield bonds, investors appear to be paying the naysayers little heed so far in 2013. After returning 12.83% and 11.05% in 2012, the two largest high yield ETFs - SPDR Barclays High Yield Bond ETF (ticker: JNK) and iShares iBoxx $ High Yield Corporate Bond Fund (HYG) - have tacked on another 0.91% and 0.78%, respectively, since the beginning of the New Year.
The strong performance of high yield bonds has been an outstanding development for anyone already invested in the asset class, but at this point the upside may be limited. The 30-day SEC yields on the two funds have fallen under 5.25%, while last week the average yield in the market as a whole fell below 6% for the first time ever. What's more, the Wall St. Journal reports, the price of the average high yield bond is now above $105 (versus a par value of $100), a level that leaves little room for further appreciation.
High yield bonds still have a lot going for them. Most important, the U.S. Federal Reserve isn't going to raise short-term interest rates any time soon, which should fuel continued demand for higher-yielding assets. Even under 6%, high-yield bonds still offer much greater income than a 10-year U.S. Treasury note yielding less than 2%. This means that high yield can continue to work for now, but any disruptions in the global financial market - such as the looming debt ceiling debate - is likely to fuel a short-term downturn in the asset class.
The takeaway for individual investors? While its always better to focus on your long-term goals rather than timing the market, it's essential to keep your expectations for high-yield bonds in check given that the market already having run so far in the past year.